Pension “de-risking” sounds like a fancy term for protecting participants’ interests in their benefits. In other words, take the risk out of pension benefits. Well, not quite. Not even close. Pension de-risking is a scheme to benefit the employers who sponsor pension plans. It refers to ways in which the employer can reduce its own risk that it may not have enough assets to pay the benefits that have been promised or just reduce the expense associated with such promises. While pension de-risking is not new to the pension world, the amount of de-risking and the type of de-risking in recent years should be concerning.
There are a few ways that pension plans can reduce their risk. Older and more common methods are to amend the plan to freeze benefits, terminate the plan altogether or make a lump sum offer to eligible participants. Another de-risking strategy that has become very popular in recent years is for an employer to purchase annuities from an insurance company which then provides the monthly payments to the pensioners. This is more commonly referred to as a “buy-out.” One need only do a simple google search of the term “pension de-risking” to find a plethora of insurance companies chomping at the bit to buy-out pension liabilities.
That begs the question, “why?” Why do insurance companies want to take on these liabilities and why do employers find them attractive? Employers find annuity buy-outs attractive for a few reasons.
First, by purchasing annuities, employers transform unknown future liabilities into a precise present cost and get those future costs off their books.
Second, and often even more attractive to employers is the fact that the cost of purchasing annuities typically is less than the cost to the employer of paying the future benefits. This is because the pension plan and the insurance companies are using different interest rates and other assumptions to determine the present value of the pension benefits into the future.
Third, employers benefit because the portion of pension participants whose benefits get transferred to the insurance company are no longer participants in the plan. That translates into lower premium payments to the Pension Benefit Guaranty Corporation (PBGC), which provides insurance for pension plan liabilities, and lower costs to operate the pension plan because fewer participants means less overall cost to administer the plan.
Finally, it means less funding requirements going forward for the employer.
Riding the Legal Edge
From the insurance company’s point of view it is, of course, all about making money. Since the 2008 financial crisis, several insurance companies have entered into the annuity business, specifically the pension asset annuity business. There are new insurance companies that have been formed for this type of business and there are old insurance companies that restructured the way they had historically operated. The structure is highly complex and rides the legal edge of several intersecting regulations, all of which may be extremely risky both for the insurance companies and for the employees whose pensions are insured. But it is that risk that generates the attractiveness for these companies because, as they say on Wall Street, the higher the risk the higher the potential gain. And this is especially true when much of that risk can be transferred to the insured employees or retirees.
A Life Insurance Company, an Asset Manager, and an Offshore Reinsurer Walk Into a Bar…
The complicated structure is broken down in a report by the Federal Reserve Board (Federal Reserve Board Capturing the Illiquidity Premium February 2020). In a nutshell, these new structures involve the life insurance company, an asset manager and an offshore captive reinsurer. The offshore captive reinsurer is often a Bermuda company. These offshore Bermuda captive reinsurance companies take on the insurance liabilities which in turn frees up capital for the life insurance company. That capital is then turned over to the asset manager who invests heavily in private debt.
This complicated high-risk structure has put pension benefits that are now being paid by insurance companies in a vulnerable position. To make matters worse, when the pension obligations are assumed by the insurance company, the employees or retirees are no longer technically plan participants and no longer have the benefit of ERISA coverage or PBGC protection. If this captive reinsurance and private equity scheme bursts, there are billions of dollars in pension assets for hundreds of thousands of plan participants that may become unrecoverable with no recourse for the plan participants.
If you think your pension benefits may be at risk, call us at 877 783 8686 or use our online form here Kantor & Kantor LLP for a free consultation to see if we can help.